INDIRECT-COST MANAGEMENT GUIDE - DAU

[Pages:134]INDIRECT-COST MANAGEMENT GUIDE

NAVIGATING THE

SEA OF OVERHEAD

Third Edition October 2001

Web edition only (not in print) PUBLISHED BY THE

DEFENSE SYSTEMS MANAGEMENT COLLEGE PRESS FORT BELVOIR, VA 22060-5426 i

Editing and Desktop Publishing: Kathryn E. Sondheimer For sale by the U.S. Government Printing Office

Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328

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PREFACE

DoD management has become increasingly concerned with broad-based increases in defense contractor indirect-cost rates. Many factors have contributed to these rate increases -- the major factor is the significant reduction in the business base for most defense contractors due to the declining defense budget. As a result, DoD has expanded efforts to strengthen monitoring indirect costs. It has become important for acquisition management personnel to thoroughly understand the complex and sensitive subject of indirect-cost management.

By teaching various program management classes at the Defense Systems Management College (DSMC), I have found that the subject of indirect cost or overhead is commonly misunderstood and is usually referred to in unfavorable terms. It is thought to be virtually uncontrollable from a government program management perspective. In addition, the large number of indirect rates one encounters in the defense industry significantly contributes to the confusion our students experience. The objective of writing this guide is to demystify what many refer to as the "sea of overhead." No single published source for the general audience of acquisition personnel provides a complete overview of indirect-cost management. This guide is intended to fill that void.

From the government perspective, monitoring indirect cost is exceptionally broad in scope; and many people are involved. So it is essential for acquisition managers to thoroughly understand the interrelationships of numerous DoD team members and how they improve the monitoring process.

This Second Edition incorporates Navy shipbuilding into government indirect-cost monitoring, describes the major new initiatives undertaken by DCMA and DCAA to accelerate settlement of final overhead rates, identifies several changes made in various contractor system review requirements, updates information related to executive compensation and restructuring costs, and eliminates prior coverage of functional reviews no longer performed by the DCMA.

To gain background information, I conducted onsite interviews with personnel actively performing indirect-management functions in industry and indirect-cost monitoring functions in the government. The arrangements were made through contacts with industry and government students at DSMC in our Advanced Program Management Courses. Recognizing that indirect rates are highly proprietary information, my interest was not in the quantification of indirect-rate data but in the business processes used to manage these difficult-to-control costs. Several contractors and government offices provided assistance to DSMC. I would like to express special appreciation to both contractor and government personnel located at Pratt-Whitney, Sikorsky, Loral Imagining Systems, and Boeing. I would also like to express appreciation to personnel in the DCMA Headquarters Overhead Center and in DCAA Headquarters who provided information relating to current issues and initiatives in their organizations.

DSMC is the controlling agency for this guide. Comments and recommendations are solicited.

Jack D. Cash Professor of Business Management Business Management Department Defense Systems Management College

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TABLE OF CONTENTS

Page Chapter 1 -- Introduction

Objective .......................................................................................................................... 1-1 Significance of Indirect or Overhead Costs ..................................................................... 1-1 Difficulty of Control ........................................................................................................ 1-4 Current Environment ....................................................................................................... 1-5 Importance of a Team Approach ...................................................................................... 1-5

Chapter 2 -- Essentials for Understanding Indirect Costs Introduction ..................................................................................................................... 2-1 Direct or Indirect ............................................................................................................. 2-1 Variable or Fixed Costs .................................................................................................... 2-4 Allowable or Unallowable Costs ..................................................................................... 2-7 Capitalized Versus Expensed ........................................................................................... 2-7 Controllable or Noncontrollable Costs ............................................................................ 2-8

Chapter 3 -- Typical Indirect-Cost Pools Overhead Pools ................................................................................................................ 3-1 Service Centers ................................................................................................................ 3-4 General and Administrative Expense Pool ...................................................................... 3-4 Major Categories of Indirect Expenses............................................................................ 3-5

Chapter 4 -- Allocation of Indirect Costs Allocation of Overhead.................................................................................................... 4-1 Allocation of General and Administrative Expenses ....................................................... 4-6

Chapter 5 -- Defense Industry Management of Indirect Costs Introduction ..................................................................................................................... 5-1 Planning ........................................................................................................................... 5-2 Forecasting....................................................................................................................... 5-7 Budgeting ...................................................................................................................... 5-10 Control ........................................................................................................................... 5-13 Variance Analysis .......................................................................................................... 5-15 Ratio Analysis ................................................................................................................ 5-15 Trend Analysis ............................................................................................................... 5-17

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Management Metrics ..................................................................................................... 5-18 Regression Analysis ....................................................................................................... 5-20 Industrial Engineering Analysis..................................................................................... 5-22 Contractor Actions to Reduce Overhead ....................................................................... 5-22

Chapter 6 -- Impact of Government Contracting Requirements Introduction ..................................................................................................................... 6-1 Relevance of Contract Type ............................................................................................. 6-2 Federal Acquisition Regulation (FAR) Requirements ..................................................... 6-5 Cost Allowability ................................................................................................. 6-6 Reasonableness .................................................................................................... 6-6 Allocability .......................................................................................................... 6-6 Generally Accepted Accounting Practices ........................................................... 6-7 Contract Terms..................................................................................................... 6-7 Selected Costs .................................................................................................................. 6-7 Advance Agreements ....................................................................................................... 6-9 Certification of Indirect Costs ......................................................................................... 6-9 Unusual Indirect-Cost Requirements............................................................................. 6-10 Independent Research and Development/Bid and Proposal Expenses .............. 6-10 Cost of Money ................................................................................................... 6-13 Current Issues ................................................................................................................ 6-15 Restructuring Costs ........................................................................................... 6-15 Executive Compensation ................................................................................... 6-18 Expiration of Funds ........................................................................................... 6-19

Chapter 7 -- Cost Accounting Standards Requirements Introduction ..................................................................................................................... 7-1 Applicability .................................................................................................................... 7-2 Disclosure Statement ........................................................................................................ 7-3 Cost Accounting Standards Relating to Indirect Costs ..................................................... 7-3 CAS 401 .............................................................................................................. 7-3 CAS 402 .............................................................................................................. 7-4 CAS 403 .............................................................................................................. 7-5 CAS 404 .............................................................................................................. 7-6 CAS 406 .............................................................................................................. 7-6 CAS 410 .............................................................................................................. 7-7 CAS 418 .............................................................................................................. 7-8 CAS 420 ............................................................................................................ 7-11 Contract Price Adjustments ............................................................................................ 7-12

Chapter 8 -- How the Government Monitors Indirect Costs Introduction ...................................................................................................................... 8-1 DCMA Overhead Center ................................................................................................. 8-2 Relationship to Program Offices ...................................................................................... 8-3

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Government Team ............................................................................................................ 8-3 Procurement Contracting Officer (PCO) .............................................................. 8-3 Administrative Contracting Officer (ACO) .......................................................... 8-4 Corporate Administration Contracting Officer/ Defense Corporate Executive (CACO/DCE) ........................................... 8-4 Defense Contract Audit Agency (DCAA) ........................................................... 8-5 Other Team Members .......................................................................................... 8-5

Monitoring Techniques .................................................................................................... 8-5 Forward-pricing Rates ......................................................................................... 8-6 Billing Rates ........................................................................................................ 8-9 Final Rates ......................................................................................................... 8-10 Tracking Indirect Costs...................................................................................... 8-13 Contractor Systems Reviews ............................................................................. 8-14 Contractor Purchasing System Reviews (CPSRs) ................................. 8-14 Estimating System Reviews (ESRs) ...................................................... 8-15 Compensation System Reviews (CSRs) ................................................ 8-15 Contractor Insurance/Pension Reviews (CIPRs) ................................... 8-16 Material Management and Accounting System (MMAS) Reviews ...... 8-17 Earned Value Management Systems (EVMSs) ..................................... 8-17 DCAA Operational Audits................................................................................. 8-19 DCAA Systems Reviews ................................................................................... 8-20 Accounting System Reviews ................................................................. 8-20 Electronic Data Processing System Reviews......................................... 8-21 Contractor Budget and Planning System Reviews ................................ 8-21 Labor System Reviews .......................................................................... 8-22 Billing System Reviews ......................................................................... 8-22 DoD "Should-Cost" Reviews ............................................................................ 8-22 Correction of Problems ...................................................................................... 8-24 Program Office and DCMA Relationship .......................................................... 8-24

Summary ...............................................................................................................................Sum-1

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